State Pension Reform Stymied by Court Opposition

Public pension reform continues to be a daunting task for advocates taking up the cause. That’s because, unlike in the private sector, the federal Employee Retirement Income Security Act (ERISA) does not apply to the pensions of government employees. Instead, state authorities, local laws, and the courts determine how public sector retirement programs are managed.

Although many states have chosen to take divergent paths, courts have stopped several of them from restructuring, forcing administrations to work within the confines of their employee retirement plans. As a result, public employers are not afforded the flexibility to adjust the rate at which a worker may accumulate benefits, even in regards to work that an employee will do in the future. This constraint inhibits pension reform and the ability to manage the high cost of underfunded, and frequently, unrestrained, public employee pensions.

Contract ISSUESWhy do courts have the authority to block the public sector from making changes to their pension plans?

In an October 16th Bloomberg article, Steven Malanga, Senior Editor of ‘City Journal’ and a Senior Fellow at the Manhattan Institute think tank, wrote, “Many legal protections given to public-sector pensions arise from court decisions that treat laws governing public retirement systems as a contract between the state and a worker.”

“That puts pensions under the jurisdiction of the contract clause of the U.S. Constitution, or under state contract law,” according to Malanga.

For decades, California courts, including the California Supreme Court, have been sticklers on upholding contract law to preserve pensions. Not only does the worker’s contract commence on the first day of employment, according to Amy Monahan, a professor at the University of Minnesota Law School and author of a 2012 Iowa Law Review article about California’s stance, but it safeguards both past and future pension accruals.

Even though federal court decisions have held that prospective changes to contracts are not unconstitutional, Monahan points out that 12 other state Supreme Courts, have, in essence, created a bloc that embraces California’s rule on pension law. These states include: Alaska, Colorado, Idaho, Kansas, Massachusetts, Nebraska, Nevada, Oklahoma, Oregon, Pennsylvania, Vermont and Washington.

In addition, California courts have stretched the rule to include other benefits such as health care. In 2011, the California Supreme Court applied the precedent to retiree health-care benefits, ruling they—like pensions—are a vested contractual right that cannot be changed. In September, a Los Angeles judge decided that the city could not freeze its retiree health-care benefits.

Other States’ EffortsThere has been a concerted effort to amend state constitutions so that governments can modify public employee retirement plans.

Not surprisingly, a leading proponent of pension reform comes from California. Chuck Reed, the mayor of San Jose, has launched a proposed ballot initiative to specifically address and abolish the Supreme Court precedent to enable pension reform. Annual payments by San Jose to fund government pensions have jumped from $73 million in 2002 to $245 million in 2012.

New Jersey voters are starting with small steps. They approved a minor change to their constitution related to the pension reform of judges. In 2011, judges disputed state legislation requiring them to contribute more to their retirement. When a state judge blocked the proposal in court, the legislature put an amendment on the ballot to change its constitution, and 83 percent of voters approved it.

The state with the unfortunate title of “worst state pension crisis in the U.S.” by Moody’s Investor Service is Illinois, where public-union leaders argue that the Illinois constitution denotes that the state cannot make changes to its pension system for current workers. Prominent Chicago law firm Sidley Austin LLP challenged that line of reasoning in a brief, saying the clause only protects benefits that have already been earned. Advocates of pension reform have advised the Illinois legislature to at least enact changes and see if the state Supreme Court rules that they meet required standards. If the court does not, amending the state constitution may finally gain some strength this time as Illinois is spending $6 billion from its $31 billion general fund on pensions, mushrooming from $1.8 billion in 2008.

Even Colorado, a supporter of the California approach, is looking at alternatives. After the state legislature reduced annual cost-of-living increases for pensions in 2010, retirees sued to stop the changes. In 2011, a district court ruled in favor of the reduction, but a superior court reversed that ruling. Colorado’s Supreme Court is now considering the case.

If Reed succeeds with his California voter initiative plan, other states may follow suit. In the meantime, difficult struggles lie ahead in The Golden State and elsewhere. However, without the ability to adjust retirement benefits yet to be earned, state taxpayers can look forward to burgeoning pension costs in the years ahead while public employees and retirees likely will see their benefits reduced through bankruptcy.

November, 2013

ABOUT THE AUTHOR: Mark Johnson, Ph.D., J.D.Mark Johnson, Ph.D., J.D., is a highly experienced ERISA expert. As a former ERISA Plan Managing Director and plan fiduciary for a Fortune 500 company, Dr. Johnson has practical knowledge of plan documents as well as an in-depth understanding of ERISA obligations. He works as an expert consultant and witness on 401(k), ESOP and pension fiduciary liability; retiree medical benefit coverage; third party administrator disputes; individual benefit claims; pension benefits in bankruptcy; long term disability benefits; and cash conversion balances.

ERISA Benefits Consulting, Inc. by Mark Johnson provides benefit consulting and advisory services and does not engage in the practice of law.

While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.